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August: FIEs were allowed to use foreign exchange settlements accounts as time deposits.. 2002: October: All enterprises with foreign trading rights including domestically-funded ente

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August: “To cut down on forex smuggling,” all Chinese and non-Chinese residents are

required to get the SAFE’s approval before taking large amounts of foreign currency abroad

August: FIEs were allowed to use foreign exchange settlements accounts as time

deposits In addition, they were allowed to obtain renminbi loans backed by foreign exchange collateral

2000：

February: The SAFE and the General Customs Administration forbid trade firms from

purchasing hard currency to pay for certain categories of imports

2001:

September: The SAFE lifted the ban on the purchase of foreign exchange for

repayment of past overdue debts Restrictions on purchasing foreign exchange for advance repayment of domestic foreign-currency denominated debts were relaxed

November: A more generous foreign exchange policy was adopted toward individuals

paying for their study abroad According to the previous regulations, individuals paying for their own study abroad could only convert their first year tuition and living expenses into foreign exchange, whereas the new rule permitted them to convert all tuition and living expenses needed throughout the period of study

2002:

October: All enterprises with foreign trading rights including domestically-funded

enterprises (DFEs) and foreign-funded enterprises (FFEs) became eligible to establish foreign exchange accounts for current international transactions

December: Foreign-funded banks were allowed to engage in buying and selling of

foreign exchange with DFEs

2003:

March: Beijing, Tianjing, Sichuan, Heilongian and other 10 provinces started experiments to relax Chinese firms’ overseas FDI requirement Renminbi assets can be used to exchange foreign currency for FDI purposes Overseas investment under $30 million can be approved by local SAFE branches in the 10 provinces/municipalities that were first to experiment with the relaxation of external investment

May: If a payment made by the foreign currency credit card exceeds the foreign

currency deposit, the difference can be paid using the renminbi

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May: Certain qualified foreign institutional investors (QFIIs) were allowed to invest in

A-shares in China

June: Chinese outward processed trade investment under $30 million can be approved at

the provincial level of the SAFE

August: Multinational corporations’ non-trade related payments are allowed to be

conducted using either foreign currency or renminbi

September: The surrender requirement was canceled for certain current account foreign

exchange earnings such as international engineering contract, labor contract, international shipping and fees and fees from shipping services

September: Residents and non-residents can bring in or take out up to $5000 per person

Domestic residents for overseas travel can carry up to $5000 in cash per person

October: New measures were issued to allow multinational corporations to conduct

cross-border foreign exchange management They include: (1) allowing eligible

multinational corporations (MNCs) to use foreign exchange funds in China to meet their foreign exchange needs overseas; (2) allowing eligible MNCs to lend foreign exchange from their operations in China to their foreign affiliates; (3) foreign exchange transactions among subsidiaries of MNCs in China no longer need approval from the SAFE Such transactions can be carried out using banks

November: The system of collecting deposits that guarantee profits from investment

abroad has been canceled

November: China agreed to provide clearing arrangements for banks in Hong Kong to

conduct personal renminbi business on a trial basis The scope of renminbi business to be offered will be confined to transactions that facilitate personal spending but do not

involve investment and other capital account transactions The scope of the renminbi business include the following four areas (1) Deposit taking services from Hong Kong residence (2) Exchange of renminbi to Hong Kong dollars and vice verse (3)

Remittances by holders of renminbi deposit accounts in Hong Kong of renminbi funds to their accounts in Mainland (4) Use by Mainland residents of their renminbi debit and credit cards issued by Mainland for spending in Hong Kong Participating banks or their subsidiaries may also issue renminbi debit or credit cards to residents of Hong Kong for use on the Mainland

2004:

September: The experiment to relax investment abroad under $30 million was expanded

to 23 provinces/municipalities It is estimated that 510 Chinese firms that took the

opportunity invested $2.1 billion in 2003—an increase of 112.3 percent (SAFE,

September 10, 2004)

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2005:

January: The amount of the renminbi in cash that can be taken out or into China was

raised from 6,000 yuan per person to 20,000 yuan per person

February: China relaxed controls on foreign exchange earning retention on tow fronts

(1) Companies are allowed to retain foreign exchange earnings above the limits up to 90 days, as opposed to the previous limit of 10 days (2) The official limits are raised to

100 % of foreign exchange earnings from the previous limits of 30% to 50% for firms that apply for higher limits Local offices of the SAFE are given the authority to approve such increases in the limits

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Appendix II Date Description and Sources

Data on spot and three months forward exchange rates for the renminbi, the U.S dollar, the Hong Kong dollar and three months deposit rates on the renminbi, the U.S dollar and the Hong Kong dollar are daily observations during 1999-2004 They are obtained from the CEIC, the People’s Bank of China, the Bank of China, the Hong Kong Monetary Authority

Data on trade (exports plus imports) and errors and omissions are from the State

Administration of Foreign Exchange

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References

Calvo G A and C Reinhart (2000), “Fear of Floating,” Dept of Economics,

University of Maryland, manuscript (http//www.bsos.umd/ed/econ/ciecalvo.htm)

Cheung, Yin-Wong, M Chinn, and E Fujii, 2003, “Perspectives on Financial Integration

in the Chinese Economy,” mimeo

Chinn, Menzie and M Dooley, 1995, “Asia-Pacific Capital Markets: Integration and Implications for Economic Activity,” NBER Working Paper #5280

Chin, Menzie and Jeffrey Frankel, 1994, “Financial Links around the Pacific Rim:

1982-1992, in R Glick and M Hutchison (eds), Exchange Rate Policy and Interdependence:

Perspective from the Pacific Basin (Cambridge: Cambridge University Press): pp17-26

Clinton, Kevin, 1988, “Transaction Costs and Covered Interest Arbitrage: Theory and

Evidence,” Journal of Political Economy, Volume 96, no.2

Dooley, Michael P., and P Isard, 1980, “Capital Controls, Political Risks, and Deviations

from Interest-Rate Parity,” Journal of Political Economy, Vol 88 no 2, pp 370-84

Frankel, Jeffrey, 1984, “The Yen/Dollar Agreement: Liberalizing Japanese Capital

Markets Policy Analyses in International Economics, no 9 Washington D.C.: Institute

for International Economics

, 1991, “Quantifying International Capital Mobility in the 1980s” in

Bernheim, D and J Shoven, eds., National Saving and Economic Performance,

University of Chicago Press (Chicago) for NBER pp 227-70

, 1992, “Measuring International Capital Mobility: A Review,” American

Economic Review, vol 82, no 2, pp 197-202

Frenkel, Jacob A and R M Levich, 1977, “Transactions and Interest Arbitrage:

Tranquil versus Turbulent Periods,” Journal of Political Economy, vol 85, no.6., pp

1209-27

International Monetary Fund, 2000, Capital Controls: Country Experiences with Their

Use and Liberalization, IMF Occasional Paper 190, May 17

Lin，Guijun, and R M Schramm, 2003, “China’s Foreign Exchange Policies Since 1979: A Review of Developments and an Assessment,” mimeo

Ma, Guonan, C Ho, and R N McCauley, 2004, “The Markets for Non-Deliverable

Forwards in Asian Currencies,” BIS Quarterly Review, pp 81-94

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Otani, Ichiro and S Tiwari, 1981, “Capital Controls and Interest Rate Parity: The

Japanese Experience, 1978-81,” IMF Staff Papers, December pp.793-815

Otani, Ichiro, 1983, “Exchange Rate Instability and Capital Controls: The Japanese

Experience, 1978-81,” in Bigman, D and T Taya eds., Exchange Rate and Trade

Instability: Causes, Consequences, and Remedies, Ballinger Publishing Co (Cambridge,

Mass.), pp.311-337

Otani, Ichiro and S Tiwari, 1990, “Capital Controls, Interest Rate Parity, and Exchange

Rates: A Theoretical Approach,” International Economic Journal, Vol 4, Number 1

(Spring), pp.25-44

Prasad, Eswar, T Rumbaugh, and Q.Wang, 2005, “Putting the Cart Before the Horse? Capital Account Liberalization and Exchange Rate Flexibility in China,” IMF PDP/05/1

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Table 1 Transaction Costs, Q4 1999 - Q4 2004

(Quarterly Rate, Quarterly Average, in Percent)

Gap in

Source: The authors' calculation.

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Table 2: China Trade and Errors and Ossimions, 1999-2004

(In Billions of U.S Dollars)

1999 2000 2001 2001 2002 2002 2003 2003 2004 2004

I H II H I H II H I H II H I H II H

Source: The State Administration of Foreign Exchange, China

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Table 3: Statistical Properties of Deviations from Uncovered Interest Parity (DUIP)

Dickey-Fuller Test

Phillips-Perron Test

(-4.16)***

(-1.53)

(-3.65)***

(3.56)***

-0.6

(-2.44)**

-0.2

(2.4)**

(-1.3)

(3.69)***

(-2.62)**

(-3.9)***

Explanatory Variable

(13.85)*** (58.8)***

(14.27)***

(-6.43)***

(-16.4)***

(-33.5)***

(-32.3)***

(-16.1)*

Note: Signs ***, **, and * indicate statistical significance at 99, 95, and 90 percent, respectively

Numbers in parentheses are t statitistics.

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Figure 1: Comparision of Deviations from Covered Interest Rate Parity Conditions

Deviation from Interest Rate Parity Condition: Offshore

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

1999Q3 2000Q1 2000Q2 2000Q3 2000Q4 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 2003Q1 2003Q2 2003Q3 2003Q4 2004Q1 2004Q2 2004Q3 2004Q4

Quarterly Mean 95% Confidence Interval (LB) 95% Confidence Interval (UB)

Deviation from Interest Rate Parity Condition: Onshore

-0.50 0.00 0.50 1.00 1.50 2.00

Deviation from Interest Parity Condition: US$ and HK$

-0.01

-0.005

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

1999Q1 1999Q2 1999Q3 1999Q4 2000Q1 2000Q2 2000Q3 2000Q4 2001Q1 2001Q2 2001Q3 2001Q4 2002Q1 2002Q2 2002Q3 2002Q4 2003Q1 2003Q2 2003Q3 2003Q4 2004Q1 2004Q2 2004Q3 2004Q4

Deviation from Interest Rate Parity Condition: Cross-Border

-0.50 0.00 0.50 1.00 1.50 2.00 2.50

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Figure 2: E&O vs change in TC

0

0.05

0.1

0.15

0.2

0.25

E&O as % of Trade

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